Triple R: Regulation, Risks, Rewards

How banks can fight climate change and turn threats into new opportunities

There were 848 climate-related catastrophes in 2019, 50% more than a decade before. This is a daunting challenge for citizens and governments and, last but not least, for banks and other financial institutions.

Extreme weather has shifted the climate change debate from discussing theory to urgently seeking practical ways to deal with it. Some of the world’s top decision-makers gathered at the World Economic Forum (WEF) in January 2020. They ranked extreme weather events, climate action failure, natural disasters, biodiversity loss and human-made environmental disasters as the five risks in the foreseeable future most likely to occupy governments, civil society, industry—and the financial sector. Davos sent out a serious warning to the world and zeb has responded with our most recent publication: the European Banking Study climate edition.

Regulators and policymakers are pushing the topic

The need for banks to adapt their businesses is even more pressing as regulators and policymakers are increasing their scrutiny of climate-related effects on the industry. In recent years, regulators have announced plans for new reporting rules, stress tests and possibly additional capital requirements. Banks have to evaluate climate change-related risks and incorporate them into their business and risk strategies.

Let’s talk about risks—and how to address them

The banking sector will have to face both, physical and transitional risks. Banks’ business models are impacted directly (e.g. credit defaults) and indirectly (e.g. higher funding costs for non-green institutions).

Given the complex interdependencies, finding the right assessment and measure for these risks poses a significant challenge. Climate-related risks can be characterized as far-reaching in scope and magnitude, non-linear, correlated and irreversible. Standard risk measures will fail here and new simulation-based models are being called for. Applying the learnings from building complex weather forecast models (e.g. early-warning systems for tsunamis) to the banking context shows first promising results. However, creating transparency and taking measures for the risk exposure is only a first step. Appropriate governance frameworks and control processes will also have to be implemented to manage these “new” risks.

Risk and regulation are two immediate fields of action for banks. Given the scale of global problems, the question is not if, but when banks will have to start measuring, simulating and disclosing climate change-related risks and their impact on business models, loan portfolios and performance indicators. Banks need to address these issues promptly.

„We may not yet know all the details on how to tackle climate change. But we do know how to help banks to reduce risks, adapt to new regulations and find rewarding new business opportunities. “

Dr. Dirk Holländer, Senior Partner

Rewarding future: how to turn threats into new opportunities

The flip side of risk is opportunity. It is becoming ever more obvious that climate change will transform the global economy as the needs and wishes of consumers and businesses change. Put differently, the global economy needs to be transformed dramatically to address climate change. Massive amounts of funds will need to be made available. This creates new business opportunities for banks. And these business opportunities are vast. They stretch from mere additional loans or bonds to providing financing for the economic transition to all other areas of the banking business, i.e. savings, asset management, treasury, capital markets and M&A. To reach carbon neutrality by 2050, EU countries are estimated to require EUR 180 to 260 bn in new funds—each year.

Read more on the aspect of opportunities for banks in our exclusive interview with Prof. Bhattacharya, H.J. Zoffer Chair in Sustainability and Ethics at the Katz Graduate School of Business, University of Pittsburgh: „There is huge scope for expert advice and client services from banks".

Together with our clients, we are working on finding solutions to all of the three dimensions highlighted before: regulation, risk and reward. We are currently engaged in a variety of projects and activities that range from offering simple information sessions to extensive design-thinking workshops about the relevance and impact of climate change on an institution. Moreover, we are developing methods and concepts for risk measurement, reporting and regulatory disclosure. Last, but not least, many of our discussions are focusing on business opportunities related to climate change—be they investment-related or driven by funding and financing needs. Our experts are more than happy to exchange views and experiences on this or any related topics.

Climate change and its impact on banks will also be the main topic of our upcoming European Banking Study 2020 (EBS). Our industry-leading study provides further insights, detailed analyses and straightforward recommendations for financial-industry executives. In a nutshell: We may not yet know all the details on how to tackle climate change. But we do know how to help banks to reduce risks, adapt to new regulations and find rewarding new business opportunities.